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June 2002

Interview with Gary Becker

REGION: I understand that you found the initial inspiration for your work on the economics of crime while searching for a parking spot.

BECKER: True story.

REGION: Would you tell us that story?

BECKER: I was coming down for an oral exam at Columbia University when I was teaching there. In those days instead of written exams for Ph.D. students, we gave them orals. And my task was to ask a half-hour of questions on price theory. I was living in the suburbs, I drove down to Columbia and I was a little late. And it's New York City, so it's not easy to find a parking place. Columbia had no parking for its faculty in those days, so either you parked illegally or you went into a parking lot. Those were your choices. So as I got there I had to make that decision. I remember making that calculation of what are my chances if I park it in an illegal spot. Or, there was a parking lot a couple of blocks away and I would have a longer walk and, of course, it cost a little money.

I started thinking about my chances of getting caught. As I walked over to the exam—it took me about 10 minutes—I'm realizing that if I'm thinking about my chances, the police, if they're being rational, must also be thinking about that. What's the likelihood, the chance of catching somebody? They don't want to spend every minute looking, so they do some kind of a probability analysis. And so they're kind of in a war against the offenders.

So I thought through some of this, and when I got to the exam the first question I asked the student was, “How do you work out that problem?” I did not think he would get the answer easily. I just wanted to see how he went about thinking about the answer. I don't remember the details of that. My impression is he did not do well. The question was a little tough. But after I finished the exam, I said, “Gee, this is an interesting topic.” I started working on it seriously at that point. That's exactly how that went.

Then I began to see a little better how to set up the problem. I set it up so that society was trying to minimize the expected loss from criminals, taking account of the damage done by the crime, cost of policing, cost of taking somebody to trial, cost of punishment, how much deterrence there would be if criminals expected greater punishment or lesser punishment, and so on. I had a model of the criminal and a model of society, and I put those two together to get a solution as to how much crime there should be.

I looked at a little data to check my simple predictions, that the more serious crimes should have greater likelihood of being convicted, which we did find, and criminals convicted of these crimes would face greater punishments, which they do. I had several students who subsequently worked on this problem and you know, crime is now a pretty vibrant area in economics.

I just came back from Mexico on Saturday. Crime may be the number one problem in Mexico. Businessmen talk about it, the average citizen talks about it. It's just a horrendous problem. Crime is a worldwide problem, more so in some countries than in others. It affects the economy, often significantly so—where people locate, where businesses locate. And I guess in a sense I began to think about it by accident. But I am very happy that accident happened.

REGION: You've had a profound influence on the field of law and economics. But five years ago, at a Law and Economics roundtable at the University of Chicago with Ronald Coase, Richard Posner and Merton Miller, you said, “Despite its enormous success, law and economics has entered a more static, more sterile period.” And I believe you also said that that period might be prolonged because its theoretical development has been largely detached from empirical research. Are you still concerned about the future of law and economics?

BECKER: Well, I am still concerned, although some of the leaders in law and economics did not like my saying that. Some of my best friends did not like it. But I believe it was an accurate statement and sometimes disguised by the fact that law and economics, which started at Chicago and then moved across the United States, has been spreading throughout the world. So it still seems very robust. I am going to a conference in Greece on law and economics, and I have been invited to several in Mexico City and Latin America. So it is a wonderful development that law and economics is spreading.

But at the pioneering level, there is less novelty. Of course there is still interesting work being done, but all fields go through a period of static development once the initial excitement wears off. I mean, that is inevitable. I do not intend to knock law and economics. Every single field within economics goes through that cycle. You can delay that more when there is a closer dialogue between the data and the theory, because then you take your inspiration from data developments rather than from what other economists or lawyers are writing about. Fields become sterile when the source of inspiration for additional work is simply the literature in the field rather than the world out there. We can see many fields where it is the literature that generates what gets done, not the problems encountered in the world.

Law and economics is not completely divorced from problems, by no means. It is much better than certain other fields in economics because it is always dealing with cases and new issues. But many of the leading law and economics people have been theorists who have not been interested in, or been very familiar with, the empirical side of things. I have nothing against having some people who are purely theorists or purely empirical. There is much room for a division of labor. But you need many people arbitraging between the empirical and theoretical sides. Unless you have that, I believe fields become sterile. You are beginning to see more of that arbitrage in law and economics. [William] Landes and [Richard] Posner have done that for many years. Still, the excitement is less in law and economics now than 20 years ago or 10 years ago, although it can revive.

REGION: If I'm not mistaken, you said that family law would be a good area in which to do more law and economics work.

BECKER: That is one of the areas I am familiar with. Family law has been looked down on in law school; it is not considered a field that top people should go into, and that is a mistake. The family is such an important institution in society. It has evolved so much. Families have not been static and have changed so much. There are many interesting areas of family law like divorce, fertility, child care, and one could go on and on. For example, should two homosexuals have the right to be parents of a child? Should they have legal rights for marriage? What should be the role of marriage contracts, of custody provisions? These issues are being discussed now, and they combine law and economics. There are only a couple of outstanding people in the law and economics field who have made family law an important part of their speciality. That's clearly one area where much more can be done with the tools of law and economics.

REGION: I'd like to turn to another policy issue. As you know, the Fed has a charge to implement the Community Reinvestment Act, basically to make sure that banks meet the lending needs of their communities. Implicit in that charge is ensuring that banks don't discriminate racially or otherwise in their lending practices. But defining and identifying discrimination in lending or in other economic endeavors is often difficult in practice. In a very real sense you laid the groundwork for this in your doctoral dissertation, which later became your first book, The Economics of Discrimination, in 1957.

So, I have a three-part question. Could you explain how you have defined that type of discrimination in the economic sense? How does your definition differ from that codified in the law? Finally, how would you change the current legal response to actions defined as discriminatory in the lending arena?

BECKER: Those are all important questions. Well, to me discrimination occurs when, let me give an example: You can hire, let's say, a man and woman at equal wages, but you prefer the man. Even if the wages were a little bit less, you would prefer the man. I would say you have a prejudice, or a preference, against women, or against blacks or Hispanics, or Chinese or foreigners, whatever the group may be. That is how I define discrimination. A person discriminates if he is willing to pay to avoid working with a woman. If you do not want a woman as your boss, you are willing to pay for that privilege. To define discrimination I use the economic concept of willingness to pay, which is crucial in all parts of economics.

REGION: Is that essentially the discrimination coefficient?

BECKER: That's the discrimination coefficient, a measure of how much you are willing to pay. Discrimination comes from prejudice, and I translate that into a monetary amount—how much you are willing to pay. So how much less would women's wages have to be than men's wages before a person is indifferent between hiring them? That is a function of how much he is willing to pay to avoid hiring women. That is what I start with.

Therefore, if you want to look at discrimination by a bank, you have to ask if the bank gets an application from, say, blacks and whites, is it giving up profits in order to avoid lending to blacks? A profit test would be the crucial test. If they are not giving up profits, then maybe they are not lending to blacks because blacks are a poor risk, they won't pay it back, they have lower incomes, they're more likely to be unemployed. So you have to look at profits.

The problem with many studies, such as the Boston Fed's study [Mortgage Lending in Boston: Interpreting HMDA Data, 1992] which has received enormous attention—and I wrote a BusinessWeek response which in turn created a furor and led to a counter-response—was what they do not look at. You see, they had a very sophisticated study but along a particular line. Namely, they said, well, let us look at the propensity to turn down black applicants and white applicants after we adjust for as many variables as we can that might make a difference. That is perfectly legitimate, as far as it goes. And they adjusted for a lot of variables, and they still found a greater propensity to turn down blacks. Even if you look at blacks and whites who have the same 50 characteristics, whatever they may be, and the study had a lot of variables, they found still a greater propensity to refuse blacks. So they concluded that there was discrimination.

Now my response was—and the response from the theory would be—well, yes, you looked at a lot and that's better than not looking at any, but we can never look at everything that bankers know. All we can do as analysts is look at the data we can get access to. We cannot get into the knowledge set or prejudices of people making the decision. OK? We cannot. So maybe they are prejudiced, but maybe they had more knowledge and we do not know that.

So I indicated that it was necessary to measure how successful were the loans made to blacks. Are they better loans for banks? Are banks making more money on these loans? Is there a lower default rate? Are they getting higher interest rates? And so on. The Fed study did not do that. Some economist subsequently did that. There is a lot of controversy now about what one finds. Some people say you do not find any difference in profitability. Others say you still find a difference. I have a student at Chicago doing still another dissertation with data on interest rates charged as well as default rates that can be used to study discrimination.

Presumably, black-owned banks do not discriminate against blacks, or not as much as white-owned banks. Are they lending to blacks in greater propensities and making a higher return on their investments? Or what are the policies and profits of female-owned banks?

I do not know the answer to those questions, but my belief is that the Boston Fed study greatly overstated the degree of discrimination by banks. That does not mean there's none. It is still an open question whether there is any and how much, but I am sure their study didn't prove that there was much discrimination.

It was unfortunate that they were willing to go so quickly from a decent study to a policy recommendation. On policy issues you have to be pretty careful. I mean, it's OK if I write about policy in BusinessWeek without firm data. It is okay for a columnist to be talking about policy without fully convincing data. Similarly, for a politician who must vote without definitive evidence. But the Fed did a research study. They should have exposed that study to criticism and waited to see what emerged before going to a policy recommendation. That is what bothered me most about the study.

REGION: So you're saying that at this point the data aren't all in; therefore, changing the legal response isn't warranted?

BECKER: That's my opinion. Other people have looked at this data and they have a different opinion. When I evaluated the data, I concluded that there does not seem to be a lot of discrimination by banks. That is my evaluation of what I have seen, but the studies are ongoing. Maybe that will be changed by further data.

REGION: You just touched on your work, in essence, as an economic educator—your column in BusinessWeek. What do you feel about the state of economic literacy in the United States? There's certainly a great deal of economic news in the public arena. But are Americans by and large sufficiently literate in economics? If not, what should be done to improve the state of affairs?

BECKER: Economics is an easy subject and a difficult subject at the same time. It is easy in the sense there are only a few principles that really guide most economic analysis. It is simple and yet it's obviously very difficult. I have dealt a lot with Nobel laureates in physics, chemistry and other fields who have very strong opinions on economic issues and usually they are terrible. These are obviously first-class minds, but they have not given economic issues much attention. They believe that they can casually talk about an economic issue and come up with the right answer, that one just has to be intelligent. This is obviously not the case. There are economic principles. If you do not use these principles, you are likely to come to the wrong answers.

Clearly the American public could be much better informed and more sophisticated. One of the problems is that members of the news media, especially those on television, are themselves not that familiar with economic principles. The print reporters are a lot better than the television people. You get some terrible economics when you listen on TV to the news; in the print media it varies a great deal. There has been an enormous improvement in the sophistication of the writings on economics by newspapers and magazines during the last 30 years. There were only a few people 30 years ago who wrote about economics in an intelligent way. Now there are many more.

Academic economists are worried that journalists do not dot all the i's and cross all the t's, but having written a regular column for many years, I have more sympathy toward journalists. They have limited space, and they must be clear but short. What is the basic message without giving all the qualifications. So while much of the journalistic economics is bad, it's greatly improved over what it was.

The American public are frightened by economics. When you mention you are an economist, people say they took an economics course in college and they were terrible at it. I believe an economist should try to get people to relax over economics, should express concepts in simple language and show how to deal with important problems in a fairly simple way. Sometimes the results are counter to their common sense, but often it's a way of articulating their common sense. They cannot articulate that very well, but once they hear it they say, gee that makes a lot of sense.

So you try to appeal to their understanding, and you carry the argument beyond where they can carry it themselves. There are some things that they cannot reason through even if you articulate the issues, so you really have to help them a lot. But much of the time you are leading them in ways that they can see. If you write well and clearly, you bring them along with you. That's what you try to do.

I was recently down in Mexico City to help launch the Spanish translation of my book, the Economics of Life, a collection of my essays that I edited with my wife. I stressed there that few important conclusions of economic analysis cannot be expressed in simple language. The challenge is to find how to do that. Many intellectuals, many economists, use obscure language when they write. Sometimes it is a way of disguising that they are not saying a heck of a lot. Of course, some propositions are tougher to express. I'm not claiming they are all equally easy. But there are few ideas for which you can't give an intelligent person a feel for the basics. The challenge to a writer is to do that.

REGION: You've done a great deal of work on intergenerational economic transfers. What are your views about social security? Should individuals be given more discretion over their social security monies? What would be the optimal design for a social security system?

BECKER: I do believe individuals should be given most of the discretion over their money, and I believe very much in a privatized system. But the selling of privatization has stressed the wrong issues. There are no magical higher rates of return from a private rather than public system. That is not the reason to privatize.

The present Social Security system is a mixture of an annuity and redistribution system. The redistribution system discourages many people from working at older ages when they are healthy enough and would want to continue working. Social Security gives them an incentive not to work because they are taxed so heavily on their earnings. It is really incredible, given that work is now much less physically demanding, and people are much more mentally and physically stronger than they used to be.

There are two inefficiencies: the first is the Social Security tax on the earnings of working people. It is a tax because workers do not get back dollar for dollar what they put in. They get back around 30 cents on each dollar they put in. Second, at the other end, the system discourages older people from working because their earnings are also taxed.

So I would like a privatized system in large measure because that could allow people to decide how much they want to save for their old age. They can get access to that savings at say age 65, whether they retire or not. A good system should separate the decision to retire from when older persons get access to their assets. The amount they save would then no longer be taxed, and the amount they get out at 65 would be either an annuity or a lump sum payment.

I also believe in a minimum standard of living for older members of our society. So if older persons, for one reason or another, did not save much, they would get a minimum level of say, Medicare and retirement income. That would be part of the welfare system for low-income people. I do not know what that amount should be. Voters have to decide that. It would be a safety net for the elderly so that they would not be dependent only on their children or private charity. However, I would separate the safety net aspect from the rest of the system—you don't want the tail wagging the dog.

REGION: I'd like to ask you about the field of behavioral economics. Much of your work has applied economic thought to sociological and psychological phenomena. These days a number of so-called behavioral economists, including your colleague Richard Thaler, are effectively reversing that looking glass by applying psychology and sociology to economic analysis. What do you think of the potential for such efforts?

BECKER: A lot depends on what is meant by behavioral economics. If that means a broadening of the scope of variables that influence people's behavior, it is quite relevant. For example, if I own a bottle of wine for two years and it appreciates a lot in value, then I may not want to sell it, even though I would not pay that much for a bottle of wine. That's sometimes called the endowment effect. It is not inconsistent with rational behavior, but economists have neglected these types of considerations.

One of the things I have tried to do in my research is to broaden the type of considerations that go into models of people's preferences. I have no problem in my vision of economics with endowment effects, fairness issues and many other considerations that affect people's preferences. Therefore, in a sense, I'm a behavioral economist.

But I would have some major differences with behavioral economics as it is usually defined. Let me say two things: First, there is a heck of a difference between demonstrating something in a laboratory, in experiments, even highly sophisticated experiments, and showing that they are important in the marketplace.

Economists have a theory of behavior in markets, not in labs, and the relevant theories can be very different. One reason is the division of labor in markets. Consider, for example, the claim by behavioral economists that most people cannot calculate probabilities accurately. I agree to some extent but am confident that people who work at blackjack tables know the relevant probabilities very well. Otherwise they don't work at these jobs. People go into activities when they are either good at those activities, or when they learn to be reasonably good. So while the average person may not calculate certain probabilities very well, they do not end up in jobs where they need to make those calculations.

A market economy is a group of specialists who are integrated by exchange. It may be that each of these specialists is terrible at other activities, but the whole aggregate can be highly efficient. The aggregate may make few mistakes. One of the things some behavioralists have missed is that a specialized economy eliminates many mistakes because vulnerable people don't get put into positions where they can make these mistakes.

The second related criticism I have is that some of the defects in behavior claimed by behaviorists tend for a different reason to be eliminated in an exchange economy. It is sometimes claimed, for example, that people's preferences are not transitive. Transitivity means that if I like a group of goods donated by A over another group, B, and B over C, then I like A over C.

Now suppose a case that violates transitivity. Suppose I prefer one apple to one orange and one orange to one pear, but I prefer one pear to an apple. That is intransitive preferences. What would happen? Someone would come to me and say since I prefer an orange to one pear, I should give him a pear plus money in exchange for an orange. Then he gives me an apple for my orange plus money. OK again. But since by assumption I prefer a pear to an apple, he gives me back my pear in exchange for the apple plus more money. I end up with the pear I started with, but I lost money in three transactions. Why? Because in each case I have given him some money plus a piece of fruit.

This is called the Dutch book argument in economic theory. I do not know if you have heard that before. I don't know where the expression comes from, but it is illustrated here by a series of exchanges that can take advantage of these intransitive preferences. Many other of the behaviorists' claims are subject to similar Dutch book arguments that either make behavior more rational, or a person goes broke. Since this is mainly an implication of exchange, it is hard for me to believe that such inconsistent behavior is important in modern
exchange-based economics.

Barnum said there's a sucker born every minute of the day. Well, suckers lose their money. Another example: I have fair dice, but you believe that a 12 is going to come up half the time. I would love to play craps against you. You will continue to lose until either you change your beliefs, or you lose your shirt. Exchange and the division of labor do not eliminate all the issues brought up by behavioral economics but I believe “behavioral” economics has a different place in modern economies than is often claimed.

To be sure, I agree that economists have often taken a very naive, materialistic, narrow approach to preferences and behaviors. I also agree that we do not want to assume that everybody is a perfect calculator. There are limits to our ability to calculate. Broader preferences and “bounded” rationality are part of a more relevant model of rational behavior. In my own way I have been trying to broaden preferences to take account of some of these points. But I am dubious about behavior that won't survive in an exchange economy with an extensive division of labor. This is where experimental and market behavior may be totally different.

REGION: This seems another area where comparing theory with empirical evidence from the marketplace is important to future development of the field.

BECKER: It's crucial. One can get excellent suggestions from experiments, but economics theory is not about how people act in experiments, but how they act in markets. And those are very different things. It is similar to asking people why they do things. That may be useful to get suggestions, but it is not a test of the theory. The theory is not about how people answer questions. It is a theory about how people behave in market situations. Once you recognize that, it is essential to have a dialogue between market behavior and the theory in order to test various hypotheses.

REGION: Let me ask about something you've just touched on. Your recent book, Social Economics that you wrote with Kevin Murphy, extends the standard utility function to include not just goods and services that individuals consume but also the social environment affecting choices and behaviors of individuals. Why is it important to broaden the conventional framework for understanding market behavior? And would you also explain how the concept of "social capital" relates to the broader notion of human capital?

BECKER: These are important questions. I believe social forces are important for many aspects of market behavior. Individuals are not Robinson Crusoes alone on islands. For some problems, the island model is a good metaphor, but for most behavior, people are influenced by what others around them are doing. Look at the popularity of certain books, for example, A Brief History of Time, by [Stephen] Hawking, the great astrophysicist. Well, nobody can understand that book. It sold millions of copies, but essentially nobody understands it. Why do they buy it? Not because they were going to read the book. I have spoken to top physicists who have trouble reading it. So the vast majority of people were buying this book for their coffee table.

To take another example, if many women are working, women who stay at home may feel a little odd. Just as in the past when most women stayed at home, those who worked felt odd. Or consider the change in attitudes about divorce. When I was growing up, a divorced woman was considered an outcast, an oddball, a loose woman. Well now, few people think so because many people are divorced.

Social phenomena are important in markets, and economists need to put more efforts into using economic analysis to incorporate social forces. To me, to Kevin and to others who are working in this field of social economics, the challenge is not to give up the economics but to incorporate social forces into the economics.
And that is, one might say, an influence from sociology onto economics, as opposed to the opposite influence. James Coleman and I started a seminar in the early 1980s on rational choice in the social sciences. Coleman was one of the greatest sociologists, and that seminar influenced my thinking on the role of social forces.

Yes, we need to incorporate some of sociology into economics, but also sociology can benefit from incorporating more economic-type thinking. Social influences affect behavior, but social influences are themselves built up from behavior. It goes both ways. For example, some chapters in our book look at the formation of social groups by neighborhoods, by income level and by other criteria. Coleman recognized the importance of these “macro” sociological problems, but he lacked the tools to fully succeed in building macro behavior from individual behavior. Economists have more tools, and a growing number of economists are trying to use economic reasoning to understand the formation of norms and social capital. Progress is being made, but it is still slow.

REGION: What is the relationship of social capital to human capital?

BECKER: I consider social capital to be a particular type of human capital. Human capital, so to speak, usually looks at a person. It is her knowledge, or her skills. Social capital looks at a person's link to other individuals. If I am involved in AA, I may be obligated to help members who are tempted to drink. In turn, I can call on them if I am having trouble with my alcohol consumption. That is an example of social capital. It is a form of human capital because it is part of me. However, it is very different from the skills I have as an educated person, or the training I have or the knowledge I have. Social capital involves a linkage among individuals. That is why it is “social.” It is capital because it has some durability, where depreciation rate may be endogenous. Anyway, that is how I look at it.

Social economics is an important field that economists are beginning to discover. Our book makes only a small beginning. But my hope has been that this small beginning will encourage others to make bigger advances as they recognize the importance of this kind of capital. I do believe economists are still too enamored of the Robinson Crusoe economy. For a lot of problems we have to recognize that, as Aristotle said, man—and woman—is a social animal, and we must incorporate that into models of behavior.

REGION: The title of your 1992 Nobel lecture was “The Economic Way of Looking at Behavior,” and in that speech you describe lucidly how you've used economics to explore several areas of human decision-making. Can one apply that same method to the decision to become an economist? More personally, as a welfare-maximizing individual, forward-looking but facing constraints, what factors were most important to your choice of economics as a profession?

BECKER: Yes, these are the factors that affect choice, but I do not believe people can make occupational choices by a fine-tuned calculation. A lot of considerations are hard to verbalize, hard to articulate.

What attracted me to economics was very simple. In high school I was active in mathematics; for example, I was on the math team. But I wanted to do something for society. When I went to Princeton, I originally planned to major in mathematics. By accident, I took a course in economics because we had to meet certain distributional requirements. I began to see then that one could use rigorous mathematics in economics to study important social problems that I wanted to deal with. I was excited about this for a couple of years at Princeton, but then I began to feel that economics was sterile. I wanted to deal with important questions, but mainly my economics courses were providing tortuous discussions of marginal utilities.

I began to contemplate leaving economics. I looked to sociology, and some sociology professors there gave me books to read on the subject, but they were too difficult. I found Talcott Parsons, who was then Mr. American Sociologist, impossible to read. I tried and I said, “I just can't make it as a sociologist. I can't understand this stuff.”

So I went back to economics. I decided to go to graduate school, came to Chicago, and by far the biggest influence on me was Milton Friedman. He is known as a monetary economist and so on, but that was not the main influence he had on me. Milton Friedman was, and is—he is still going strong—a great economist, who saw the power of economics as a tool of analysis to discuss real problems. I saw then that my discouragement when a senior at Princeton was misplaced. It was just my teachers' approach, and much of my reading. But economics could deal with the problems I was interested in, and it could be exciting to me.

And so I made the decision then to pursue economics as a career. I liked this subject a lot, although I was unsure about how creative I would be as a professor of economics. I did not believe I would earn as much as a professor as turned out to be. I remember I went to my mother, I said Mom, I want to be a professor. She said, but you will only make $10,000 a year. That was not much even then, although we have to adjust for price level changes—this was a long time ago. I replied that it would be enough for me. And she said, well you will discover it isn't enough for you. (My father was a reasonably successful businessman.) I said perhaps, but I did not care at age 22 about money.

So I did not make a fine-tuned calculation. I do not believe people usually make such calculations. I say to people who ask me if they should do this or do that, that they should think about the pros and cons, but often it comes down to things that we cannot articulate fully.

I had a gut feeling I should go to Chicago rather than Harvard for graduate study—those were the two places I was considering—and Chicago was clearly the right decision for me.

I had a feeling economics was what I wanted to do. I did not know if I would be good at it, but it seemed exciting to me. Is that making a fine calculation? Is that being behavioral? Is that being an economic man? It is being an economic man in a very general way. We are dealing with an uncertain future. By choosing economics, I would be going into something I liked, and I had the math. Indeed, compared to students of my generation in economics, I had a lot of math. So in a sense I was making a calculation, but it was a very loose calculation. Typically, I do not believe a young person can make a better occupation-choice calculation than that.

The important point is that markets are more “rational” than individuals. Markets assign persons to jobs and professions. If I did not get a good academic job, then I may have put my talents to some other use. Many behaviorists do not appreciate that markets have a lot more rationality than any one person does. Economists are really analyzing markets and how they work.

I did well in economics. I made more money than I thought I would make, and got more acclaim than I thought I would get, so it turned out to be a good decision. But if others made a mistake by going into economics, some of these left, or left research or left teaching. So I believe rough as it was, my decision to enter economics was a “rational”decision, but people do not literally make a fine-tuned calculation.

How many people sit down before they marry and say, oh these are the reasons I should marry this woman, these are reasons why I should not marry her, then weigh these and see if the pluses exceed the minuses? Very few people do that. If your girlfriend knew you did that, she probably would not want to marry you. But implicitly, most people ask if marriage will make them happier. Is this the best they can do? Are they in love? Is this the right decision for them? And they make mistakes. That is why couples divorce. But the marriage market functions well as a whole. So I return to my emphasis on markets—economics is a theory of markets. The theory of the individual is just a way of attacking market problems. That is my view.

REGION: A final question. As you know, the Minneapolis Fed has an ongoing concern with the policy of too-big-to-fail—that is, the policy in which governments implicitly ensure that large banks will be protected from failure because such failures could spill over to the broader economy. This in turn raises the problem of moral hazard, the worry that large banks may take on excessive risk if they believe they will be bailed out by central banks or other government entities. What advice would you give to central banks that wish to avoid creating moral hazard, while still hoping to reduce the likelihood that a large bank failure could spill over to the entire banking system?

BECKER: Moral hazard is a real problem. Look at Argentina now—I am writing a column about Argentina [published in BusinessWeek, Feb. 11]. That country was able to borrow $140 billion, mainly in dollars, partly because financial institutions and other lenders expected that Argentina would be bailed out of any crises by the International Monetary Fund and the U.S. government. Otherwise, I do not believe Argentina could have borrowed so much, even at the higher rates they were forced to pay. I hope neither the IMF nor the U.S. government helps these lenders. They have to take the consequences of their poor decisions, and we have to send a message to lenders that they will not get help if they make bad investments.

Of course, the Fed has to worry about contagions and runs on banks. But I do not believe the best way to reduce contagions is to bail out banks that fail. I have opposed bailouts of even large banks, such as the bailout of Continental Illinois of Chicago many years ago.

To be sure, the Fed should provide enough liquidity to the banking system when a large bank fails, but deposit insurance and other safeguards help do that. The Fed should also make sure that banks can survive temporary liquidity problems by borrowing from the Fed and by selling assets. If the Fed does that, the
too-big-to-fail argument is weak.

I was against the Fed's helping Long-Term Capital Management. In discussing this with Peter Fisher [then executive vice president] at the New York Fed, he said that the Fed did very little. That is possible. I do not know how much behind-the-scenes arm twisting there was. An offer was on the table from Warren Buffett. He wanted to let Long-Term Capital investors retain 5 percent of their equity; the actual deal ended up giving them 10 percent. The Buffett offer might have been accepted if the Fed had not become involved.

I can understand why the Fed was concerned about the consequences of a collapse of LTCM, but it does not seem to me that this merited the Fed getting involved. I say this even though some of my friends were partners in Long-Term Capital, and I greatly respect them. I have no objection if the Fed only, as Fisher claimed, facilitated a purely private sector transaction.

I do not like the Fed's involvement—even if innocuous—because there is too much room for politics. The big challenge to international and domestic monetary policies is to separate the economics from the politics. Often, unfortunately, the politics dominates. So one should try to build a structure that minimizes the impact of politics. The too-big-to-fail argument is likely to be driven mainly by politics.

REGION: And to maintain a time-consistent policy?

BECKER: Yes, time-consistent policies. People should know what the policies will be, and that these policies will be followed in a time-consistent way. [The Minneapolis Fed's] Ed Prescott is one of the pioneers on time consistency. This is one reason why I favor simple rules for monetary policy. They are knowable and are easier to separate from politics.

REGION: Thank you, Mr. Becker.

—Douglas Clement